I covered the methods of mitigating inheritance tax last week and was asked a question regarding equity release to mitigate the tax where the property or home may be causing the tax.
As house prices have rocketed, so too has the value of our taxable estates. Inheritance tax is charged at 40% on assets over the nil rate band of £325,000. Both spouses and civil partners have that nil rate band which can be transferable between each other.
In 2017, the government introduced the residence nil rate band where property is passed to direct descendants such as children or grandchildren. This allowance is £175,000. So, a couple have their nil rate band of £325,000 each, alongside their residence nil rate band which gives them £500,000 allowance each, totalling £1 million.
In simple terms, if their property was their only asset, and it was worth less than £1 million, there would be no inheritance tax.
Common complaints which drove poor outcomes that have come out of the Financial Services Consumer Panel research into equity release are: making a rushed decision, not understanding finance, feeling vulnerable to pressure, being blinkered by the desire for having funds in their bank account, being too single minded about their decision and not seeking independent financial advice.
Much of this is true in many of our financial decisions, so it’s no surprise. The gentleman in the car showroom asking you if you can really afford that shiny car, and asking if it’s a good decision, would be a significant anti-climax when you have already visualised it at the front of your house.
So, consider each of the above drivers of poor outcomes first before taking out equity release.
That said, equity release does have a part to play particularly as the house is only one part of the taxable estate.
The tricky part to lower the value of the estate is that the property is a fixed asset i.e. no liquidity. You can’t give it away and live in it because that would be a gift with reservation. If you have liquid assets (money) there are plans which could be considered such as trusts but not if the asset is fixed (there is no money).
An option is to take out an equity release against the property. That creates a debt against your estate which reduces the estate. Furthermore, the interest rolls up and creates a bigger debt against the estate, reducing your inheritance tax liability.
Of course, you now have that released money in your bank account, which is an asset you need to do something with. You can now gift it outright to whoever you wish and after seven years it is outside your estate. You have lost all control of that money.
Those who want to still enjoy its benefits might consider placing the borrowed money into one of the many trusts available to continue to withdraw an ‘income’ or withdrawals. For example, you could place the capital into a gift and loan trust. With this option, all growth on the capital is outside your estate but you have access to what you placed into the trust. Meanwhile, the debt on the equity release is rolling up inside your estate.
You could consider a discounted gift trust also. You borrow £200,000 against the home. That money is placed into trust with, say 4% withdrawals each year. After seven years, the initial gift and the growth are all outside the estate and once again, the roll up debt is inside the estate. The whole gift is outside the estate after seven years.
Furthermore, the withdrawals you will be taking are your right to your capital, and a calculation is made actuarily to ascertain how much would normally (given your life expectancy) come back to you. The initial gift is then immediately discounted by that amount.
There are many options to consider reducing inheritance tax and both your boredom levels and my space in this column prohibit the detail, but I hope this give a flavour of the choices.
It is essential to seek independent financial and legal advice to ensure equity release is the right option for your specific circumstances.
- Peter McGahan is chief executive of independent financial advisers Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you need advice, or have a question you would like us to answer, call Pat Greene on 028 6863 2692 or email pgreene@wwfp.net
